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Tuesday, August 14, 2012

Evidence of Chinese Economic Problems

Because of the press of work and other commitments, I am taking a short hiatus from blogging--probably one to two weeks. However, I wanted to share a few interesting articles on China that I've come across the past several days.

The first is from the Diplomat, entitled "Superpower Denied?" The gist of the article is that China has systemic problems that, if not corrected, will result in the last several representing the apex of Chinese power (at least in the next several decades). The author writes:

... Has China's rise peaked?

If one were to pose this question a few years ago, he would probably be laughed out of the room. The conventional wisdom then was that China's rise was certain to continue. But today, this question is very much on everyone's mind.

What has changed?

Almost everything.

If one has to take a position, it may be reasonable to argue that the Beijing Olympics in 2008 symbolically marked the peaking of Chinese power. Everything began to go downhill afterwards. Caught up in the global economic crisis, the Chinese economy has never fully recovered its momentum. To be sure, Beijing's stimulus package of 2008-2009, fueled by deficit spending and a proliferation of credit, managed to avoid a recession and produce one more year of double-digit growth in 2010. For awhile, Beijing's ability to keep its economic growth high was lauded around the world as a sign of its strong leadership and resilience. Little did we know that China paid a huge price for a misguided and wasteful stimulus program. The bulk of its stimulus package, roughly $1.5 trillion (with two-thirds in the form of loans from state-owned banks), was squandered on fixed-asset investments, such as infrastructure, factories, and commercial real estate. As a result, many of these projects are not economically viable and will saddle the banking system with a mountain of non-performing loans. The real estate bubble has maintained its froth. The macroeconomic imbalance between investment and household consumption has barely improved. Today, Chinese economic policy-makers are hamstrung in trying to revive economic growth. The combination of local government indebtedness, massive bad loans hidden in the banking system, anemic external demand, and diminishing returns from investments has made it all but impossible for Beijing to use the same old economic playbook to fire up the economy.

Short-term difficulties are not the least of Beijing's worries. In the coming decade, many of the favorable structural factors that have helped power China's double-digit growth in the past two decades are going to disappear. Topping the list is the demographics. The proportion of the Chinese population of working age peaked in 2011 and has started decreasing in 2012, according to a RAND study. At the same time, the share of the elderly in the population is beginning to rise rapidly.

The latter issue is the birth-dearth conundrum faced by many developed (and developing countries)--that they will become old before they become rich--due to costs for caring for the elderly while, at the same time, the number of workers supporting them declines. (The situation is, of course, aggravated when you have high unemployment rates, such as Spain and Greece, where more than half of young adults are unemployed; meaning that the number of workers supporting "pensioners" is less than it otherwise could be).

Anyway, the article goes on to summarize other problems facing China, including severe environmental degradation (having failed to realize the simple truth that you should not defecate where you sleep), the extreme legal and political bias favoring state-owned enterprises over private businesses, increasing resistance to its growing power by neighboring countries (although I suspect that China's "Vietnam" will be in Africa, Latin America or the old standby, Afghanistan), and increased political agitation within China.

On a related note is the article "You'll Never Be Chinese" at Prospect Magazine. The author, who lived in China in the 1980's as a student, and since 1996 as a businessman, relates:

When I returned to China in 1996, to begin the life and career I had long dreamed about, I found the familiar air of optimism, but there was a subtle difference: a distinct whiff of commerce in place of community. The excitement was more like the eager anticipation I felt once I had signed a deal (I began my China career as a metals trader), sure that I was going to bank a profit, rather than the thrill that something truly big was about to happen.

A deal had been struck. Deng had promised the Chinese people material wealth they hadn’t known for centuries on the condition that they never again asked for political change. The Party said: “Trust us and everything will be all right.”

Twenty years later, everything is not all right.

* * *

Modern day mainland Chinese society is focused on one object: money and the acquisition thereof. The politically correct term in China is “economic benefit.” The country and its people, on average, are far wealthier than they were 25 years ago. Traditional family culture, thanks to 60 years of self-serving socialism followed by another 30 of the “one child policy,” has become a “me” culture. Except where there is economic benefit to be had, communities do not act together, and when they do it is only to ensure equal financial compensation for the pollution, or the government-sponsored illegal land grab, or the poisoned children. Social status, so important in Chinese culture and more so thanks to those 60 years of communism, is defined by the display of wealth. Cars, apartments, personal jewellery, clothing, pets: all must be new and shiny, and carry a famous foreign brand name. In the small rural village where we live I am not asked about my health or that of my family, I am asked how much money our small business is making, how much our car cost, our dog.

The trouble with money of course, and showing off how much you have, is that you upset the people who have very little. Hence the Party’s campaign to promote a “harmonious society,” its vast spending on urban and rural beautification projects, and reliance on the sale of “land rights” more than personal taxes.

Once you’ve purchased the necessary baubles, you’ll want to invest the rest somewhere safe, preferably with a decent return—all the more important because one day you will have to pay your own medical bills and pension, besides overseas school and college fees. But there is nowhere to put it except into property or under the mattress. The stock markets are rigged, the banks operate in a way that is non-commercial, and the yuan is still strictly non-convertible. While the privileged, powerful and well-connected transfer their wealth overseas via legally questionable channels, the remainder can only buy yet more apartments or thicker mattresses. The result is the biggest property bubble in history, which when it pops will sound like a thousand firework accidents.

In brief, Chinese property prices have rocketed; owning a home has become unaffordable for the young urban workers; and vast residential developments continue to be built across the country whose units are primarily sold as investments, not homes. If you own a property you are more than likely to own at least three. Many of our friends do. If you don’t own a property, you are stuck.

When the bubble pops, or in the remote chance that it deflates gradually, the wealth the Party gave the people will deflate too. The promise will have been broken. And there’ll still be the medical bills, pensions and school fees. The people will want their money back, or a say in their future, which amounts to a political voice. If they are denied, they will cease to be harmonious.

Meanwhile, what of the ethnic minorities and the factory workers, the people on whom it is more convenient for the government to dispense overwhelming force rather than largesse? If an outburst of ethnic or labour discontent coincides with the collapse of the property market, and you throw in a scandal like the melamine tainted milk of 2008, or a fatal train crash that shows up massive, high level corruption, as in Wenzhou in 2011, and suddenly the harmonious society is likely to become a chorus of discontent.

Just a few years after Chinese companies lined up to sell shares on Wall Street, a growing number are reversing course and pulling out of U.S. exchanges.

This week, Focus Media Holding Ltd., announced its chairman and private equity firms want to buy back its U.S.-traded shares and take the Shanghai-based advertising company private. The deal would value Focus Media at $3.5 billion, according to financial information firm Dealogic.

Smaller companies also are withdrawing from U.S. exchanges. In a sign of official encouragement, a Chinese business magazine said a state bank has provided $1 billion in loans to help companies with listings abroad move them to domestic exchanges.

The withdrawals follow accusations of improper accounting by some companies and a deadlock between Beijing and Washington over whether U.S. regulators can oversee their China-based auditors.

Some Chinese companies say they are pulling out of U.S. markets because a low share price fails to reflect the strength of their business. Withdrawing also eliminates the cost of complying with American financial reporting rules.

At first blush, this article could be interpreted as a slam against the U.S. economy--that it is not strong enough to support Chinese companies. But this is not the issue. It is the financial reporting rules.

Despite what the MSM would have you believe, the U.S. actually requires a higher level of financial transparency for the benefit of investors than most any other country in the world. Thus, publicly traded companies must not only comply with SEC regulations on necessary disclosures (as well as rules prohibiting insider trading), but must also produce financial statements that comply with GAAP (generally accepted accounting principles) and comply with the rules of the whichever exchange on which their stock is traded.

I suppose that "costs" of compliance may be a factor, but I suspect strongly that the real reason is that the Chinese companies don't want the transparency. The question is: Why don't they want the transparency? It could be a culture of corruption in the management of the companies. It could also be that they don't want to release details of bad debts and investments, or declining revenue, or other financial ills that would otherwise have to be disclosed. The fact that the Chinese government is helping bail them out makes the latter more plausible.